At last week's OECD forum in Paris – a gathering of the great and the good from the world of economics and public policy – much of the focus was on the drama being acted out in Brussels, as Europe's leaders met over dinner and failed, yet again, to resolve the debt crisis.

But apart from trying to guess Angela Merkel's next move, there was one hot political topic that came up repeatedly in Paris: inequality. The Occupy protesters may have been forced to move their motley collection of tents from outside St Paul's, but their argument that something has gone profoundly wrong with a capitalism that has allowed "the 99%" to fall so far behind has hit a nerve.

The anti-austerity vote in the Greek elections earlier this month, and the growing confidence of protest groups such as the indignados in Spain, has revealed the political limits of an economic approach that involves punishing those on modest incomes for the sins of the elites.

In the summary of their discussions, OECD ministers promised to "tackle increasing inequalities through 'making work pay' approaches, support for low-income households, financial inclusion, as well as investment in people and jobs". There may be few concrete results, but it's now becoming increasingly fashionable to acknowledge that inequality is an economic problem in its own right, as well as a question of social justice.

For a long time, the growing gap between rich and poor caused hand-wringing among lefties, but was dismissed by many economists – and the political consensus – as an unfortunate but inevitable side-effect of the battle to subdue inflation, and, later, of technological change and globalisation.

An excellent new paper by James Galbraith, the economist son of a famous economist father, presented in Paris but as yet unpublished, helps explain how we got here. He argues that it is crucial to understand how the west, and economists, responded to the oil shocks of the 1970s.

Instead of using industrial or employment policies to share the pain of readjustment, or re-tool the economy to cope with the higher cost of energy, the rich world treated the crisis as purely a "price shock" – an inflation problem. The answer was to ramp up interest rates, smash the bargaining power of the unions, and tolerate levels of unemployment that would once have been considered unacceptable, in the cause of slaying the beast of inflation.

Once Margaret Thatcher took the reins in Britain, and Ronald Reagan in the US, this inflation-busting mantra became entwined with the pernicious myth that deregulating financial markets and allowing market thinking to penetrate new areas of life would lead to a better, safer world. The result was an economy in which the 99% were left far behind: inequality soared from the 1980s on both sides of the Atlantic. Later, the story went that the growing importance of the hi-tech "weightless economy," and the outsourcing of metal-bashing manufacturing to low-wage economies such as China, had polarised income between highly educated and highly paid "knowledge workers" and low-skilled wage slaves who suddenly had to compete with cut-price Chinese and Indian factory staff.

It was all very sad for the losers in this new winner-takes-all economy, but the grand prize was meant to be the "Great Moderation": a long period of steady, consistent growth and low inflation across much of the rich world.

Unfortunately, the Great Moderation now appears to have been, in hindsight, the Brief Respite from economic tumult, driven by short-term factors such as China's entry into the world economy and a huge consumer credit boom.

Meanwhile, beneath the level of broad-brush economic statistics, rising inequality was having pernicious effects of its own. A recent paper written by the National Institute of Economic and Social Research (NIESR) for the Resolution Foundation thinktank shows that low-income households in the UK only maintained their standard of living through the late 1990s and early 2000s by borrowing heavily.

There is a popular argument, put forward by Ben Broadbent at the Bank of England among others, that the UK's unprecedented levels of household debt don't matter, and won't hold back recovery, because they have been matched by a sharp increase in assets.

That sounds right if you think of homeowners matching their rising mortgages against rocketing house prices. But NIESR found that, in fact, it was overwhelmingly the poor doing the borrowing through this period while the rich were accumulating the assets. Over the decade to 2007, for example, the bottom 10% of households saw their incomes grow by 17% but their spending rise by 43%. As NIESR puts it: "Given only a minority of the poorest are homeowners paying off their mortgage, it is highly unlikely this was counterbalanced by an increase in housing wealth."

Without this borrowing binge, it is likely that consumption would have collapsed, and with it growth. And because many poor families are now hamstrung by unpayable debts, demand may be held back for years. So it seems rising inequality does matter – economically, as well as politically.

And it is this history – of decades in which lavish rewards accrued to the few while everyone else papered over the cracks with debt – that could make austerity impossible to bear.

As Galbraith puts it, "social upheaval is a possibility", because "those advocating that the costs fall mainly on the low- and moderate-income population, through cuts in retirement, medical care, education and public infrastructure, must realise that those affected will make the next move".